What is Mezzanine Financing?
Mezzanine Financing in commercial real estate authorizes a lender to convert a debt into equity in the event that a borrower defaults. For example, if the borrower fails to pay the debt in a timely manner, the lender has the right to take action by taking a portion of the investment property and then selling it to pay off that debt.
One of the advantages of a mezzanine debt is the ability for flexible financing, as well as the low probability that an owner will lose ownership or control of a property. However, compared to a senior debt, a mezzanine debt is riskier due to a lack of collateral from the borrower. Therefore, the interest rate tends to be higher and more covenants are included.
Mezzanine Financing is beneficial for an individual who is looking to purchase a commercial real estate property for the first time. It can also benefit someone who simply wants to expand their property, but does not have enough funds.
Mezzanine Financing vs. Preferred Equity
For commercial real estate developers who need more funds to build or purchase a project, preferred equity is becoming an increasingly popular alternative to mezzanine financing. Unlike mezzanine financing, which is debt with an equity conversion option, preferred equity grants the outside investor direct equity in the project itself. Preferred equity also gives the outside investor a fixed rate of return.